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IBAT Midterms

The Global Trade and Investment Environment
Topic/s: International Trade Policies
Managing any business strategically needs an
understanding of the business policies. But in case of
global companies, an understanding of trade policies is
more essential. International trade policies deal with the
policies of the national governments relating to exports
of various goods and services to various countries either
on equal terms and conditions or on discriminatory terms
and conditions.
Protectionism & Barriers to Trade
Trade disputes between countries happen because one
or more parties either believes that trade is being
conducted unfairly, on an uneven playing field, or
because they believe that there is one or more economic
or strategic justifications for import controls.
Tariff refers to the tax imposed on imports. It is a duty or
tax imposed on internationally traded commodities when
they cross the national borders. The objectives of Tariffs
• To protect domestic industries from foreign
• To guard against dumping
• To promote indigenous research and development
• To conserve foreign exchange resources of the
country To make the balance of payments position
more favorable and
• To discriminate against certain countries.
Tariff affects the economy in different ways. An import
duty generally has the following effects:
Protectionism represents any attempt to impose
restrictions on trade in goods and services. The aim is to
cushion domestic businesses and industries from
overseas competition and prevent the outcome resulting
from the inter-play of free market forces of supply and
Protective effect:
An import duty is likely to increase the price of imported
goods. This increase in the price of imports is likely to
reduce imports and increase the demand for domestic
goods. Import duties may also enable domestic
industries to absorb higher production costs. Thus, as a
result of the protection by tariffs, domestic industries are
able to expand their output.
Dumping is an international price discrimination in which
an exporter firm sells a portion of its output in a foreign
market at a very low price and the remaining output at a
high price in the home market.
Consumption Effect:
The increase in prices resulting from the levy of import
duty usually reduces the consumption capacity of the
Objectives of Dumping:
1. To Find a Place in the Foreign Market:
2. To Sell Surplus Commodity:
3. Expansion of Industry:
Types of Trade Barriers
Trade barriers can be broadly divided into the following
two categories:
- Tariff barriers refer to duties and taxes imposed by
the government on the goods imported from abroad.
- Tariff barriers restrict imports indirectly.
- Non-tariff barriers are various quantitative and
exchange control restrictions imposed in order to
restrict imports.
- Non-tariff barriers restrict imports directly.
Government announces their trade policies with regard
to the following from time to time.
They are also called the instruments of trade policy. They
are: Tariffs, Subsidies and Import quotas.
Redistribution Effect;
If the import duty causes an increase in the price of
d o m e s t i c a l l y p ro d u c e d g o o d s , i t a m o u n t s t o
redistribution of income between the consumers and
producers in favor of the producers. Further a part of the
consumer income is transferred to the exchequer by
means of the tariff.
Revenue Effect:
As mentioned above, a tariff means increased revenue
for the government.
Income and Employment Effect;
The tariff may cause a switch over from spending on
foreign goods to spending on domestic goods. This
higher spending within the country may cause an
expansion in domestic income and employment.
Competitive Effect:
The competitive effect on the tariff is, in fact, an anticompetitive effect in the sense that the protection of
domestic industries against foreign competition may
enable the domestic industries to obtain monopoly
power with all its associated evils.
Terms of trade effect:
In a bid to maintain the precious level of imports to the
tariff imposing country, if the exporter reduces his prices,
the tariff importing country is able to get imports to a
lower price.
Quota is direct restriction on the quantity of goods which
are imported into a country. These restrictions are
imposed by issuing import licenses to certain firms and
individuals to import certain quantity of the goods. India
had quotas of imports of various goods like cars,
motorcycles, milk etc. up to 31st March 2001. Import
quotas provide the protection to the domestic firms from
the foreign countries.
Balance of Payment Effect:
As quotas enable a country to restrict the aggregate
imports within specified limits, quotas are helpful in
improving its balance of payments position.
Price Effect:
As quotas limit the total supply, they may cause an
increase in domestic prices.
Consumption Effect:
If quotas lead to an increase in prices, people may be
constrained to reduce their consumption of the
commodity subject to quotas or some other
Protective Effect:
By guarding domestic industries against foreign
competition to some extent, quotas encourage the
expansion of domestic industries.
Redistributive Effect:
Quotas also have a redistributive effect if the fall in
supply due to important restrictions enables the
domestic producers to raise prices. The rise in prices will
result in the redistribution of income between the
producers and consumers in favor of the producers.
Revenue Effect:
Quotas may also have a revenue effect. As quotas are
administered by means of licenses, the government may
obtain some revenue by charging a license fee.
Terms of Trade Effect;
Quotas may affect the terms of trade of the country
imposing them. The effect of quotas on the terms of
trade depends upon the elasticity of the foreign offer
The differences between tariffs and quotas will be clear
by the following way of comparison:
Let us first examine the superiority of quotas to tariffs:
1. As a protective measure, a quota is more effective
than the tariff. A tariff seeks to discourage imports
by raising the price of imported articles. It however
fails to restrict imports when the demand for imports
is price inelastic.
2. When compared to tariffs, quotas are much precise
and their effects much more certain. The reactions
or responses to tariffs are not clear and accurately
predictable; but the effect of quotas on imports is
3. It has been argued that quotas tend to be more
flexible; more easily imposed and more easily
removed instruments of commercial policy than
tariffs. Tariffs are often regarded as relatively
permanent measures and rapidly build powerful
vested interests, which make them all the more
difficult to remove. Quotas have many
characteristics of a more temporary measure, are
designed to deal only with a current problem, and
removable as soon as circumstances warrant.
4. Quotas, however, suffer from certain effects. Tariffs
in some respects are superior to quotas.
5. The effects of quotas are more rigorous and
arbitrary, and they tend to distort international trade
much more than the tariffs. That is why GATT
condemns quotas and prefers tariffs to quotas for
controlling imports.
6. Quotas tend to restrict competition much more than
tariffs by helping importers and exporters to acquire
monopoly power. If import quotas are allocated only
to a few importers, they may enable them to amass
fortunes by exploiting the market. Similarly, quotas
tend to promote the concentration of economic
power among foreign exporters.
7. Quotas may support inflationary pressures within
the country by restricting supply. Tariffs also suffer
from the same defect.
8. Quotas offer greater scope for corruption than
In order to encourage domestic production or to protect
the domestic producer from the foreign competitors,
government pays to a domestic producer reducing
operations cost. Such payments are called subsidies.
Subsidies are in different forms. They are cash grants,
loans and advances at low rate of interest, tax holidays,
government procurement of output at a higher rate,
equity participation and supply of inputs at lower prices.
The Global Trade and Investment Environment
After the Second World War the developing countries are
making concerted efforts to achieve rapid economic
growth and thereby alleviate problems of poverty and
employment. The developing countries have been facing
the problems of shortage of capital. To meet this
shortage capital flows from the developed countries to
the developing countries in the last two decades have
substantially increased.
Foreign institutions such as banks, insurance companies,
companies’ managing mutual funds and pension funds
purchase stocks and bonds of companies of other
countries in the secondary market. They get returns in
the form of capital gain and dividends.
Foreign Direct Investment Strategies
The flow of foreign direct investment could occur through
international acquisition or Green field investment. When
a firm undertakes FDI, it becomes a multinational
enterprise. FDI occurs when a company invests in real
assets in a foreign country to produce or to market a
Mergers and Acquisitions
An international acquisition is a cross boarder investment
in which a foreign investor acquires an established local
firm and makes the acquired local firm a subsidiary
business within its global portfolio and local company
becoming an affiliate of the foreign company. Crossborder mergers occur when the assets and operation of
firms from different countries are combined to establish a
new legal entity. Mergers are the most common way for
multinationals to do FDI.
Greenfield Investment
This may be defined as direct investment in new facilities
or the expansion of existing facilities. Greenfield
investments are the primary target of a host nation’s
promotional efforts because they create new production
capacity and jobs, transfer technology and know-how,
and can lead to linkages to the global marketplace.
The Organization for International Investment cites the
benefits of Greenfield investment (or in sourcing) for
regional and national economies to include increased
employment (often at higher wages than domestic firms);
investments in research and development; and additional
capital investments. Criticism of the efficiencies obtained
from Greenfield investments includes the loss of market
share for competing domestic firms. Another criticism of
Greenfield investment is that profits are perceived to
bypass local economies, and instead flow back entirely
to the multinational's home economy
Foreign Direct Investment Concepts
FDI can be classified as Horizontal foreign direct
investment and Vertical foreign direct investment.
Horizontal Foreign Direct Investment
Horizontal foreign direct investment occurs when a
multinational enterprise (MNE) enters a foreign country to
produce the same products produced at home. It
represents a geographical diversification of the MNE’s
established domestic product line.
Right time for Horizontal foreign direct investment could
be any of the following:
• When an organization can gain monopolistic
characteristic in particular area or region
• When an organization competes in a growing industry
• When increased economies of scale provide major
competitive advantages
• When an organization has both the capital and human
talent needed to successfully manage the expanded
• When competitors are faltering due to lack of
managerial expertise or a need for particular
resources that an organization possesses.
Vertical Foreign Direct Investment
Vertical FDI is company’s investment into an industry
abroad, which provides control of the different stages of
making its product from raw materials through
production to its final distribution.
Vertical FDI may be in two types:
1. Backward vertical FDI
Backward FDI occurs when the MNE enters a foreign
country to produce intermediaries goods that are
intended to use as inputs in its home country.
Strategy when to go for backward FDI
• when an organization’s present suppliers are especially
expensive or unreliable or incapable of meeting the
firm’s needs for parts, components, assemblies or raw
• when the number of suppliers is small and the number
of competitors is large
• when an organization competes in an industry that is
growing rapidly
• when an organization has both capital and human
resources needed to manage the new business of
supplying its own raw materials
2. Forward vertical FDI
Forward FDI occurs when the MNE markets its
homemade products overseas or produce final outputs in
a host country using its home-supplied intermediate
goods or materials.
Strategy when to go for forward FDI
• when an organization’s present distributors are
especially expensive or unreliable or incapable of
meeting the firm’s distribution needs
• when the availability of quality distributors is so limited
• when an organization has both capital and human
resources needed to manage the new business of
distributing its own products
Reasons for Direct Investment
• Risk reduction – minimizing risk and optimize revenue.
• Market potential – Future returns
• Overcoming trade barriers
• Motive
- Natural Resource-Seeking
- Market-Seeking
- Efficiency-Seeking
- Strategic-Asset-Seeking Labor –Seeking
- Technology-Seeking
- Support Industry-Seeking
- Industrial Facilitation-Seeking
- Strategic Opportunity-Seeking
Advantages of Foreign Direct Investment (FDI)
• introducing new technology, modern skills, innovations
and new ideas
• create new employment opportunity
• when part of the profit again put into the business
moderation or expansion can be occurred
• most direct investment flow into export industries. By
increasing exports reducing imports it will improve
balance of payments of capital importing country
• FDI induces domestic investment in the form of joint
participation or in local ancillary industries
• FDI increases the productive capacity of the capital
importing country
• FDI induces to invest in infrastructure such as power,
telecom, and developments of ports. It is not only
accelerating the economic growth of the capital
importing country but also attract foreign investors
Disadvantages of Foreign Direct Investment (FDI)
• profit exploitation
• new technology doesn’t always ensure expected level
of employment
• there are chances to give up activities, if it is
happening, this will create severe problems
• avoiding pay to tax
• crate political instability
• create cultural abuse
• introducing corrupt culture
• exploiting the resources and misuse it
Regional Economic Integration can best be defined as an
agreement between groups of countries in a geographic
region, to reduce and ultimately remove tariff and non-
tariff barriers to the free flow of goods, services, and
factors of production between each other.
The following are examples of Regional Economic
• NAFTA (North American Free Trade Agreement)-An
agreement among the U.S.A., Canada, and Mexico.
• EU (European Union)-A trade agreement with 15
European countries.
• APEC (Asian Pacific Economic Cooperation Forum) This includes NAFTA members, Japan, and China.
Economic Integration
There are varying levels of economic integration,
including preferential trade agreements (PTA), free trade
areas (FTA), customs unions, common markets and
economic and monetary unions. The more integrated the
economies become, the fewer trade barriers exist and
the more economic and political coordination there is
between the member countries.
By integrating the economies of more than one country,
the short-term benefits from the use of tariffs and other
trade barriers is diminished. At the same time, the more
integrated the economies become, the less power the
governments of the member nations have to make
adjustments that would benefit themselves. In periods of
economic growth, being integrated can lead to greater
long-term economic benefits; however, in periods of poor
growth being integrated can actually make things worse.
The trend of regional economic integration was further
reinforced by the development of modern technologies in
the fields of construction, telecommunication, heavy
machinery, road, rail and air transportation, shipping and
c o n t a i n e r s e r v i c e s , fi n a n c e a n d b a n k i n g a n d
development of micro/macro computers and internet.
Association of Southeast Asian Nations (ASEAN)
The Association of Southeast Asian Nations, or ASEAN,
was established on 8 August 1967 in Bangkok, Thailand,
with the signing of the ASEAN Declaration (Bangkok
Declaration) by the Founding Fathers of ASEAN, namely
Indonesia, Malaysia, Philippines, Singapore and
Brunei Darussalam then joined on 7 January 1984, Viet
Nam on 28 July 1995, Lao PDR and Myanmar on 23 July
1997, and Cambodia on 30 April 1999, making up what
is today the ten Member States of ASEAN.
ASEAN Community consists of three pillars, namely the
• Asean Political-Security Community (APSC),
• The Asean Economic Community (AEC)
• The Asean Socio-Cultural Community (ASCC).
North American Free Trade Agreement (NAFTA)
The North American Free Trade Agreement (NAFTA),
signed by Prime Minister Brian Mulroney, Mexican
President Carlos Salinas, and U.S. President George
H.W. Bush, came into effect on January 1, 1994. Since
1993, NAFTA has generated economic growth and rising
standards of living for the people of all three member
countries. By strengthening the rules and procedures
governing trade and investment throughout the
continent, NAFTA has proved to be a solid foundation for
building Canada’s future prosperity.
In January 1994, when Canada, the United States and
Mexico launched the North American Free Trade
Agreement (NAFTA), the world's largest free trade area
was formed. The Agreement has brought economic
growth and rising standards of living for people in all
three countries. In addition, NAFTA has established a
strong foundation for future growth and has set a
valuable example of the benefits of trade liberalization.
The objectives of this Agreement, as elaborated more
specifically through its principles and rules, including
national treatment, most-favored-nation treatment and
transparency, are to:
1. Eliminate barriers to trade in, and facilitate the
cross-border movement of, goods and services
between the territories of the parties;
2. Promote conditions of fair competition in the free
trade area;
3. Increase substantially investment opportunities in
the territories of the parties;
4. Provide adequate and effective protection and
enforcement of intellectual property rights in each
party's territory;
5. Create effective procedures for the implementation
and application of this agreement, for its joint
administration and for the resolution of disputes;
6. Establish a framework for further trilateral, regional
and multilateral cooperation to expand and enhance
the benefits of this Agreement.
7. The Parties shall interpret and apply the provisions
of this Agreement in the light of its objectives set out
in paragraph 1 and in accordance with applicable
rules of international law.
Relation to Other Agreements
1. The Parties affirm their existing rights and
obligations with respect to each other under
theGeneral Agreement on Tariffs and Tradeand other
agreements to which such Parties are party.
2. In the event of any inconsistency between this
Agreement and such other agreements, this
Agreement shall prevail to the extent of the
inconsistency, except as otherwise provided in this
Relation to Environmental and Conservation
1. In the event of any inconsistency between this
Agreement and the specific trade obligations set out
• The Convention on International Trade in
Endangered Species of Wild Fauna and Flora,
done at Washington,
• March 3, 1973, as amended June 22, 1979,
• The Montreal Protocol on Substances that Deplete
the Ozone Layer, done at Montreal, September 16,
1987, as amended June 29, 1990,
• t h e B a s e l C o n v e n t i o n o n t h e C o n t ro l o f
Transboundary Movements of Hazardous Wastes
and Their
• Disposal, done at Basel, March 22, 1989, on its
entry into force for Canada, Mexico and the United
States, or d. The agreements set out in Annex
such obligations shall prevail to the extent of the
inconsistency, provided that where a Party has a choice
among equally effective and reasonably available means
of complying with such obligations, the Party chooses
the alternative that is the least inconsistent with the other
provisions of this Agreement.
2. The Parties may agree in writing to modify Annex
104.1 to include any amendment to an agreement
referred to in paragraph 1, and any other
environmental or conservation agreement.
Extent of Obligations
The Parties shall ensure that all necessary measures are
taken in order to give effect to the provisions of this
Agreement, including their observance, except as
otherwise provided in this Agreement, by state and
provincial governments.
Organization of the Petroleum Exporting Countries
Mission: In accordance with its Statute, the mission of
the Organization of the Petroleum Exporting Countries
(OPEC) is to coordinate and unify the petroleum policies
of its Member Countries and ensure the stabilization of
oil markets in order to secure an efficient, economic and
regular supply of petroleum to consumers, a steady
income to producers and a fair return on capital for those
investing in the petroleum industry.
Member Countries
The Organization of the Petroleum Exporting Countries
(OPEC) was founded in Baghdad, Iraq, with the signing
of an agreement in September 1960 by five countries
namely Islamic Republic of Iran, Iraq, Kuwait, Saudi
Arabia and Venezuela. They were to become the Founder
Members of the Organization.
These countries were later joined by Qatar (1961),
Indonesia (1962), Libya (1962), the United Arab Emirates
(1967), Algeria (1969), Nigeria (1971), Ecuador (1973),
Gabon (1975) and Angola (2007). Currently it has total of
21 members.
European Union (EU)
The European Community was formed in 1952; it has
now become the framework for the present European
Union. The European Union is a trade agreement
between 15 European countries. The Maastricht Treaty
was signed in 1992. From this treaty, a single market was
formed on January 151, 1993. As the EU moves toward a
closer economic union and a further enlargement, they
plan on instituting a single currency called the Euro. With
the promise of ultimately removing barriers and creating
a free flow of goods between the European countries, the
integration will create new opportunities and should
show a substantial net gain from regional free trade
The goals of the European Union are:
• promote peace, its values and the well-being of its
• offer freedom, security and justice without internal
• sustainable development based on balanced
economic growth and price stability, a highly
competitive market economy with full employment
and social progress, and environmental protection
• combat social exclusion and discrimination
• promote scientific and technological progress
• enhance economic, social and territorial cohesion and
solidarity among EU countries
• respect its rich cultural and linguistic diversity
• establish an economic and monetary union whose
currency is the euro.
Joining the EU
Becoming a member of the EU is a complex procedure
which does not happen overnight. Once an applicant
country meets the conditions for membership, it must
implement EU rules and regulations in all areas.
Any country that satisfies the conditions for membership
can apply. These conditions are known as the
‘Copenhagen criteria’ and include a free-market
economy, a stable democracy and the rule of law, and
the acceptance of all EU legislation, including of the
A country wishing to join the EU submits a membership
application to the Council, which asks the Commission
to assess the applicant’s ability to meet the Copenhagen
criteria. If the Commission’s opinion is positive, the
Council must then agree upon a negotiating mandate.
Negotiations are then formally opened on a subject-bysubject basis.
Due to the huge volume of EU rules and regulations each
candidate country must adopt as national law, the
negotiations take time to complete. The candidates are
supported financially, administratively and technically
during this pre-accession period.
The Global Monetary System
In today’s world no economy is self-sufficient, so there is
need for exchange of goods and services amongst the
different countries. So in this global village, unlike in the
primitive age the exchange of goods and services is no
longer carried out on barter basis. Every sovereign
country in the world has a currency that is legal tender in
its territory and this currency does not act as money
outside its boundaries. So whenever a country buys or
sells goods and services from or to another country, the
residents of two countries have to exchange currencies.
So we can imagine that if all countries have the same
currency then there is no need for foreign exchange.
With the globalization of economic and financial activity,
and advancement in the telecommunication sector, the
planet became a neighborhood in a short period of time.
International trade, which encompasses economic and
financial activity, coupled with the interdependencies in
economic resources among nations, requires a payment
system that facilitates and brings efficiency to these
The Foreign Exchange Market or FOREX Market is one
in which foreign currency or foreign exchange is bought
and sold, either Over the Counter (OTC) or through
currency exchanges.
It is one of the important components of the International
Financial Systems. The various commercial and financial
transactions as between countries result in receipts and
payments as between them. Such receipts and
payments involve exchange of one currency for another.
For example: Peso is a legal tender in the Philippines but
an exporter in UK will have no use for these pesos. He,
therefore, wishes to receive from the importer in
Philippines only in Pound sterling. Then the Importer
have to convert such pesos into pounds, in that
transaction, Foreign Exchange Market provides facilities
for such operations. Any receipt and payment of foreign
cash, coins, claims in currencies or credit instruments
involve a foreign exchange transaction.
The ForEx market facilitates international trade and
payment systems among nations by altering their
currencies. Nations’ macroeconomic stability is heavily
dependent upon the value of their currency in relation to
others with whom they trade. Various financial securities
are utilized by nations to satisfy debt incurred through
international trade or other economic interaction. The
rate by which the two currencies are valued is
determined by the amount of the currencies exchanged
as a result of export and import, transactions in the
international bond market, and exchange of goods and
services between countries. In the international capital
market, the term arbitrage refers to transacting in foreign
currencies to take advantage of fluctuations that occur in
the value of currencies as a result of macroeconomic
- Forex first existed in ancient time. Money-changing
people, people helping others to change money and
also taking a commission or charging a fee were living
in the times of the Talmudic writings (Biblical times).
- These people used city stalls to exchange money.
- In earlier times the major money exchangers were the
silver smiths and the gold smiths.
Medieval and later
- During the fifteenth century the Medici family were
required to open banks at foreign locations in order to
exchange currencies to act for textile merchants.
- To facilitate trade, the bank created the account book
which contained two columned entries showing
amounts of foreign and local currencies, information
pertaining to the keeping of an account with a foreign
- During the 17th (or 18th) century Amsterdam
maintained an active forex market.
- During 1704 foreign exchange took place between
agents acting in the interests of the nations of England
and Holland.
Before WWII
- 1899 to 1913: holdings of countries foreign exchange
increased by 10.8%, while holdings of gold increased
by 6.3%. At the time of the closing of the year 1913,
nearly half of the world's forexes were being
performed using sterling.
- 1919 to 1922: the employment of a foreign exchange
brokers within London increased to 17. During the
1920s the occurrence of trade in London resembled
more the modern manifestation
- 1923 to 1930: In 1924 there were 40 firms operating
for the purposes of exchange.
- by 1928 forex trade was integral to the financial
functioning of the city. Continental exchange controls,
plus other factors, in Europe and Latin America,
hampered any attempt at wholesale prosperity from
trade for those of 1930's London.
After WWII
- 1953-1959: In Japan the law was changed during
1954 by the Foreign Exchange Bank Law, so, the Bank
of Tokyo was to become because of this the center of
foreign exchange by September of that year. Between
1954 and 1959 Japanese law was made to allow the
inclusion of many more Occidental currencies in
Japanese forex.
- 1961-1970: During 1961-62 the amount of foreign
operations by the U.S. of America's Federal Reserve
was relatively low. Those involved in controlling
exchange rates found the boundaries of the
Agreement were not realistic and so ceased this in
March of 1973, when sometime afterward none of the
major currencies were maintained with a capacity for
conversion to gold, organizations relied instead on
reserves of currency. 1970-1973: During 1970 to 1973
the amount of trades occurring in the market increased
three-fold. At some time (according to Gandolfo during
February-March 1973) some of the markets were
"split", so a two tier currency market was
subsequently introduced, with dual currency rates.
Reuters introduced during June of 1973 computer
monitors, replacing the telephones and telex used
previously for trading quotes.
After 1973
- In fact, 1973 marks the point to which nation-state,
banking trade and controlled foreign exchange ended
and complete floating, relatively free conditions of a
market characteristic of the situation in contemporary
times began (according to one source), [although
another states the first time a currency pair were given
as an option for U.S.A. traders to purchase was during
1982, with additional currencies available by the next
- On 1 January 1981 (as part of changes beginning
during 1978) the Bank of China allowed certain
domestic "enterprises" to participate in foreign
exchange trading. Sometime during the months of
1981 the South Korean government ended forex
controls and allowed free trade to occur for the first
time. During 1988 the countries government accepted
the IMF quota for international trade.
- Intervention by European banks especially the
Bundesbank influenced the forex market, on February
the 27th 1985, particularly the greatest proportion of
all trades world-wide during 1987 were within the
United Kingdom, slightly over one quarter, with the
U.S. of America the nation with the second most
places involved in trading.
Foreign Exchange Market is widespread throughout the
globe, market participants are specialists, transactions
involve immense volume and involvement of variety of
Functions of Foreign Exchange Market
Forex v/s other Financial Markets
The Forex (or currency) market is one of four financial
markets. These markets include the stock, bond,
commodity, and currency markets. Each market has its
own special characteristics that attract banks and
financial institutions to trade its products. Individuals
have only recently been permitted to trade in the
currency markets. Previously, the Forex market was
traded primarily by banks, large financial institutions, and
governments. Individuals have been trading in the other
financial markets for many years. Here are few basic
characteristics of the other markets and their major
differences with the Forex market.
SPOT: A spot transaction is a two-day delivery
transaction (except in the case of trades between the US
Dollar, Canadian Dollar, Turkish Lira, EURO and Russian
Ruble, which settle the next business day), as opposed
to the futures contracts, which are usually three months.
This trade represents a “direct exchange” between two
currencies, has the shortest time frame, involves cash
rather than a contract; and interest is not included in the
agreed-upon transaction.
FORWARD: One way to deal with the foreign exchange
risk is to engage in a forward transaction. In this
transaction, money does not actually change hands until
some agreed upon future date. A buyer and seller agree
on an exchange rate for any date in the future, and the
transaction occurs on that date, regardless of what the
market rates are then. The duration of the trade can be
one day, a few days, months or years. Usually the date is
decided by both parties. Then the forward contract is
negotiated and agreed upon by both parties.
SWAP: The most common type of forward transaction is
the swap. In a swap, two parties exchange currencies for
a certain length of time and agree to reverse the
transaction at a later date. These are not standardized
contracts and are not traded through an exchange. A
deposit is often required in order to hold the position
open until the transaction is completed.
FUTURE: Futures are standardized forward contracts
and are usually traded on an exchange created for this
purpose. The average contract length is roughly 3
months. Futures contracts are usually inclusive of any
interest amounts.
OPTION: A foreign exchange option (commonly
shortened to just FX option) is a derivative where the
owner has the right but not the obligation to exchange
money denominated in one currency into another
currency at a preagreed exchange rate on a specified
date. The options market is the deepest, largest and
most liquid market for options of any kind in the world.
International trade - Trade of goods and services
between countries is the major reason for the demand
and supply of foreign currencies. The value or strength or
weakness of a countries currency in terms of other
currencies depends on its trade with those countries. If a
country’s imports are higher, the demand for foreign
currency in this country will be high. Higher demand for
foreign currency means high value of foreign currency
and low value of the domestic currency. This is a typical
case for underdeveloped countries which rely on imports
for development needs. The current account balance
(deficit or surplus) thus reflects the strength and
weakness of the domestic currency.
Capital movements - International investments in the
form of Foreign direct investment (FDI) and Foreign
institutional investments (FII) have become the most
important factors affecting the exchange rate in today’s
open world economy. Countries which attract large
capital inflows through foreign investments, will witness
an appreciation in its domestic currency as its demand
rises. Outflow of capital would mean a depreciation of
domestic currency.
Change in prices - Domestic inflation or deflation affects
the exchange rate by affecting the demand and supply of
domestic currency in the foreign exchange market. For
example, if prices in India go up, making Indian goods
costlier, the demand for
Indian goods will do down. When exports go down, the
demand for rupee will fall, causing depreciation in its
exchange value.
Speculations - Uncertainties are always there in the
financial market. Speculators predict about the future
exchange rate based on various happenings in the world,
in various countries. Speculators study the various ups
and downs of a country and its resilience to international
happenings and forecast the possible future exchange
rate based on a particular countries economic strengths
and weaknesses. If the speculators expect a fall in the
value of a currency in the near future, they will sell that
currency and start buying the other currency that they
expect to appreciate. The selling of the former currency
will thus increase its supply in the foreign exchange
market and bring down its value. The other currency
appreciates as its demand increases.
Strength of the economy - If the economic
fundamentals of a country are strong, the exchange rate
of its domestic currency remains stable and strong.
Fiscal balance, international current account balance,
international liabilities, foreign exchange reserves,
resilience to international trade fluctuations, GDP,
inflation rate all are indicators of a country’s economic
Government policies - In countries where there is fixed
or managed float, the central bank becomes an
important player in the foreign exchange market. The
bank influences the value of the currency by its market
operations like buying and selling of bills and currencies.
The bank rate also influences the exchange rate by
influencing investments and thereby the demand and
supply of the domestic currency.
Stock exchange operations - Stock exchange
operations in foreign securities, debentures, stocks and
shares, influence the demand and supply of related
currencies, thus influencing their exchange rate.
Political factors - Political scenario of the country
ultimately decides the strength of the country. Stable
efficient government at the center will encourage positive
development in the country, creating successfulinvestors investor and a good image in the international
market. An economy with a strong, positive image will
obviously have a strong domestic currency. This is the
reason why speculations rise considerably during the
parliament elections, with various predictions of the
future government and its policies. In 1998, the Indian
rupee depreciated against the dollar due to the American
sanctions after India conducted the Pokharan nuclear
Gross Domestic Product (GDP): GDP is considered the
broadest measure of a country's economy, and it
represents the total market value of all goods and
services produced in a country during a given year. Since
the GDP figure itself is often considered a lagging
indicator, most traders focus on the two reports that are
issued in the months before the final GDP figures: the
advance report and the preliminary report. Significant
revisions between these reports can cause considerable
volatility. The GDP is somewhat analogous to the gross
profit margin of a publicly traded company in that they
are both measures of internal growth.
Consumer Price Index (CPI): The CPI is a measure of
the change in the prices of consumer goods across over
200 different categories. This report, when compared to
a nation's exports, can be used to see if a country is
making or losing money on its products and services. Be
careful, however, to monitor the exports - it is a focus
that is popular with many traders because the prices of
exports often change relative to a currency's strength or
The Global Monetary System
Topic: International Monetary System
To understand the future, we need to consider the past.
In the chaos from the international credit crisis, bank
defaults and share market crashes, what does the future
hold and how did this international monetary system
develop to what it is today?
What will be the character of the international monetary
system in the next century and how will gold and other
currencies intersect with it? This course may strike as a
strange topic, but I can assure you that, back in the past,
when people were deliberating about the future of the
international monetary system, gold figured importantly
in the discussions. Even today, the importance of gold in
the international monetary system is reflected in the fact
that it is today the only commodity held as reserve by the
monetary authorities, and it constitutes the largest
component after dollars in the total reserves of the
international monetary system.
International Monetary System (IMS) defines the
overall financial environment in which multinational
corporations and international investors operate. It is a
rules and procedures by which different national
currencies are exchanged for each other in world trade.
Such a system is necessary to define a common
standard of value for the world’s currencies. IMS is set of
internationally agreed rules, conventions and supporting
institutions that facilitate international trade. IMS has
grown over a period of time and has successfully tackled
periods of stress and strains. It has passed a period of
transition from the system of fixed exchange rates to the
system of floating rates.
• The process of coin debasement in England during
1542-1551. By 1560 the full bodied coins almost
completely out of circulation.
• The coinage act of 1792 in the USA accepted the
dollar as the monetary unit of the country and fixed its
value of gold and silver.
• France adopted the bimetallic standard in 1803 but
the mint ratio between the gold and silver was 1:15 in
the USA compared to 1:15.5 in France.
Classical gold standard:
The gold standard possessed broader features than the
specie commodity standard. it originated in England in
the seventeenth century when the pound was minted of
gold but it was officially announced in 1816.by the 1870’s
the gold standard was widely adopted. Germany
adopted it in 1871 and USA in 1879.
The essential features of the gold standard were:
- The government adopting it fixed the value of currency
in terms of specific weight and fineness of gold and
guaranteed two-way convertibility.
- Export and import of gold were allowed so that it could
flow freely among the gold standard countries.
- Central bank acting as the apex monetary institution,
held gold reserves in direct relationship with the
currency it had issued.
- Each currency has a specified gold content – par
- Currency can be converted into and out of gold at their
par value No government interference.
Interwar period:
World War 1 ended the classical gold standard in August
1914, as major countries such as Great Britain, France,
Germany, and Russia suspended redemption on
banknotes in gold and imposed embargoes on gold
export. After the war, many countries especially
Germany, Australia, Hungary, Poland, and Russia,
suffered hyperinflation. The Germany experience
provides a classical example of hyperinflation. By the
end of 1923, the
The IMS went through several distinct stages of
evolution. These stages are summarized as follows.
WPI in Germany was more than 1 trillion times as high as
the prewar level.
In early days, prior to the evaluation of an IMS, trade
payments were settled through barter, but there were
many inconveniences and so to overcome those
difficulties, traders began using metal, especially gold or
silver for settling payments. Subsequently metal took the
form of coins. The coins were full bodied coins meaning
that their value was equal to the value of metal contained
therein. Later, the process of coin debasement the value
of metal came to lower than the face value of the coin.
Debased coins were largely used as medium of
Bretton Woods’s system:
In July 1944, representatives of 44 nations gathered at
Bretton woods, New Hampshire, to discuss and design
the post war international monetary system. After lengthy
discussions and bargains, representatives succeeded in
drafting and signing the article of agreement of the
international monetary fund (IMF).
“IMS can be defined as the institutional framework which
international payments are made, movements of capital
are accommodated and exchange rates among
currencies are determined”.
The agreement was ratified majority of countries to
launch the IMF in 1945. Delegates also created a sister
institution, the international bank for reconstruction and
development (IBRD), better known as WORLD BANK.
Under Bretton woods system, each country established
a par value in relation to the
U.S. dollar which was
pegged to gold at $35 per ounce.
Over the past 200+ years, the world has gone through
major changes its global exchange rate environment.
Pros of gold standard
- It was an efficient system of hedging against inflation
because aggregate amount of money to be supplied is
trial up in the amount of Gold the country has in its
reserve. This prevents excessive money supply.
- The system ensures stable exchange rate because it
avoids deliberate devaluation and revaluation of the
- The system ensued an automatic adjustment in the
balance of payments because the International
settlement and fund flows were tied up in the amount
of gold in reserve in each country
- The system is an efficient method of transferring
values because there is a single and common not of
value among countries. i.e the gold.
Flexible exchange rate regime:
In the view of collapse of Bretton woods system of
exchange rate, the board of governors of IMF appointed
committee of 20 suggests guidelines for evolving an
exchange rate system that could be acceptable to the
member countries. The report suggested various options
that were discussed at Rambouillet in November 1975.
The broad options under the new exchange rate regime
• Floating –independent and managed
• Pegging of currency
- To a single currency
- To a basket of currencies
- To SDR’s
- Crawling peg
- Currency board arrangement
• Target zone arrangement
Regime of Fixed Exchange Rates:
• In this system, a currency is pegged to a foreign
currency with fixed parity.
• The rates are maintained constant or they may
fluctuate within a narrow range.
• When a currency tends crossing over the limits,
governments intervene to keep it within the band.
• A country pegs its currency to the currency of the
country in which the major foreign transactions are
carried out.
• Some countries peg their currencies to SDR.
The currencies to which many other currencies are
pegged are:
USD (24 currencies)
French Franc (14 currencies)
SDR (4 currencies)
Cons of gold standard
- The money supply in a country in Gold standard is
affected by factors affecting the supply of Gold in that
country. Thus the Government or monetary authority
cannot pursue any type of monetary policy. No room
for monetary policy
- There is a danger of deflation due to the tendency of
fixing the supply of money to the amount of Gold in
reserve. Lack of expansion in money supply may affect
productivity and reduce output and thus affect the
gross of the economy is general
- Countries on Gold standard have no authority as far as
monetary policy matters are concerned. Monetary
issues are governed by the monetary system
- There is no follow up system ensuring that all countries
on Gold standard stick to the rule. Having their money
supply tied up in the amount of Gold they have in
Pros of Bretton wood System
- It economies on Gold by allowing the foreign reserves
to be in USD.
- Effecting payment through USD is easier than the use
of gold
- Exchange rates stability under the wood system,
reduce currency risk and international monetary
becomes stable.
- The stability of USD meant a stable international
monetary system
Cons of Bretton wood system
- The Britton wood system depended entirely on the
stability of the USD in the 1960’s the USA government
adopted an expansionary monetary policy. In attempt
to reduce unemployment and increase the supply of
USD. This destabilized the system.
Pros of flexible (floating) exchange rate system
- All countries under the system have control over the
monetary policy they can increase or decrease the
money supply according to circumstances prevailing.
- The true value of each currency i.e. the exchange rate
can be established through the forces of demand and
supply i.e. It is possible to attend an equilibrium
exchange rate for the currency
A flexible exchange rate system cam maintains the
balance of payment equilibrium by bringing about a
balance between inputs and exports
Cons of flexible(floating)exchange rate system
- Currency risk increases due to variability of the
exchange rates currencies. This is a special concern of
multinational companies.
- The Central bank may misuse their power as far as the
money supply is concerned this may lead to excessive
money supply and increase in inflation rate
One issue rarely considered by economists or Reserve
Bank Governors, is the cost of creating new money when
it enters the financial system. The money supply of a
country usually needs to expand as the amount of goods
and services in a country expands, so that there is
enough money to purchase these good and services.
This is a fine balancing act, too much money in
circulation leads to inflation, but too little also leads to
deflation, as was experienced during the Great
Depression. However, as this money comes into
circulation through government open market operations
and consequently the money multiplier effect of the
banking system, it enters society as an interest-bearing
debt. This cost has a compounding effect and must
certainly create an unnecessary cost to society.
Returning to the gold standard would appear highly
unlikely. Nothing has changed in the world to expect that
what happened back in the days of the original gold
standard would not happen again. Gold in itself has very
little intrinsic value or real use, just like fiat currency.
World renown British economist, John Maynard Keynes,
floated the idea of a world currency he called the bancor.
Neither took off at the time because there was an
advantage for the country whose currency was the
reserve currency, not having to balance their balance of
payments. Although a world currency, by whatever name,
may encourage world trade even more, and also remove
uncertainties of currency fluctuation, the problems of a
lack of fiscal responsibility and discipline that are
currently affecting the EU will also haunt a world
currency. There also needs to be competition between
currencies, for as surely as communism failed due to lack
of competition, so too would a single world currency. The
major problems that need addressing by world powers
are transparency in our financial institutions, public
expenditure, deficits and limiting quantitative easing, all
of which are the core of monetary stability and the
international monetary system.
The Global Monetary System
Topic/s: The Global Capital Market
money that is invested in return for a percentage of
ownership but is not guaranteed in terms of repayment.
The increasing integration of global capital markets now
makes it easier for firms to access capital outside of their
home countries. Firms access international capital
markets through a variety of means such as initial public
offerings (IPO), seasoned equity offerings (SEO), crosslistings, depository receipts, special purpose acquisition
companies (SPACS), shelf offerings, private equity and
other informal equity capital channels. Firms can also
access debt resources outside their market through bank
loans, and foreign bond issues. Finally, cross border
flows of venture capital (VC) continue to increase rapidly.
The objective of this Special Issue will be to explore the
challenges firms face in capital markets beyond their
domestic boundaries, be it equity, debt, or VC markets.
In essence, governments, businesses, and people that
save some portion of their income invest their money in
capital markets such as stocks and bonds. The
borrowers (governments, businesses, and people who
spend more than their income) borrow the savers’
investments through the capital markets. When savers
make investments, they convert risk-free assets such as
cash or savings into risky assets with the hopes of
receiving a future benefit.
While International Business (IB) research continues to
evaluate the challenges facing firms in foreign product
markets, IB scholars have yet to adequately address the
underlying reasons why firms face challenges in foreign
equity markets. These include underpricing, higher
underwriting and professional fees, higher listing fees,
audit fees, and greater risk of lawsuits, and home bias on
the part of investors.
For example, let’s imagine a beverage company that
makes 1 million in gross sales. If the company spends
900,000, including taxes and all expenses, then it has
100,000 in profits. The company can invest the 100,000
in a mutual fund (which are pools of money managed by
an investment company), investing in stocks and bonds
all over the world. Making such an investment is riskier
than keeping the $100,000 in a savings account. The
financial officer hopes that over the long term the
investment will yield greater returns than cash holdings
or interest on a savings account. This is an example of a
form of direct finance.
International Capital Markets
Capital Market
This transfer mechanism provides an efficient way for
those who wish to borrow or invest money to do so. For
example, every time someone takes out a loan to buy a
car or a house, they are accessing the capital markets.
Capital markets carry out the desirable economic
function of directing capital to productive uses.
Since all investments are risky, the only reason a saver
would put cash at risk is if returns on the investment are
greater than returns on holding risk-free assets. Basically,
a higher rate of return means a higher risk.
In other words, the beverage company bought a security
issued by another company through the capital markets.
In contrast, indirect finance involves a financial
intermediary between the borrower and the saver. For
example, if the company deposited the money in a
savings account, and then the savings bank lends the
money to a company (or a person), the bank is an
intermediary. Financial intermediaries are very important
in the capital marketplace. Banks lend money to many
people, and in so doing create economies of scale. This
is one of the primary purposes of the capital markets.
In the example, the beverage company wants to invest
its 100,000 productively. There might be a number of
firms around the world are eager to borrow funds by
issuing a debt security or an equity security so that it can
import 100,000 in cash or in a low-yield savings account.
The other firms would also have had to put off or cancel
their business plans.
While there are many forms of each, very simply, debt is
money that’s borrowed and must be repaid, and equity is
International capital markets are the same mechanism
but in the global sphere, in which governments,
companies, and people borrow and invest across
national boundaries. In addition to the benefits and
purposes of a domestic capital market, international
capital markets provide the following benefits:
purchase plants and equipment, fund R&D projects, pay
wages, and so on.
A share of stock gives its holder a claim to a firm’s profit
stream. The corporation honors this claim by paying
dividends to the stockholders. The amount of the
dividends is based on how much profit the corporation is
A debt loan requires the corporation to repay a
predetermined portion of the loan amount (the sum of the
principal plus the specified interest) at regular intervals
regardless of how much profit it is making.
The structure of the capital markets falls into two
components—primary and secondary. The primary
market is where new securities (stocks and bonds are the
most common) are issued. If a corporation or
government agency needs funds, it issues (sells)
securities to purchasers in the primary market. Big
investment banks assist in this issuing process as
intermediaries. Since the primary market is limited to
issuing only new securities, it is valuable but less
important than the secondary market.
The vast majority of capital transactions take place in the
secondary market. The secondary market includes stock
exchanges, bond markets, and futures and options
markets, among others. All these secondary markets
deal in the trade of securities. The term securities include
a wide range of financial instruments. You’re probably
most familiar with stocks and bonds. Investors have
essentially two broad categories of securities available to
them: equity securities, which represent ownership of a
part of a company, and debt securities, which represent
a loan from the investor to a company or government
Debt loans include cash loans from banks and funds
raised from the sale of corporate bonds to investors.
When an investor purchases a corporate bond, he
purchases the right to receive a specified fixed stream of
income from the corporation for a specified number of
years (i.e., until the bond maturity date).
The main players in a generic capital market
The Figure is an illustration of the main players in the
capital market.
In the case of international capital
markets, there are simply more of all of these players and
a greater diversity in the players and the possible
Functions of a generic capital market
Today by using international capital markets, firms can
lower the costs and increase their access to funds.
Investors are also diversifying their portfolios and
reducing their systematic risk by investing internationally,
although new risks are created in the process.
The generic capital market brings together those who
want to invest such as corporations, individuals, nonbank financial institution as well as those who want to
borrow such as individuals, companies, governments.
Market makers are the commercial and investment banks
that connect investors with borrowers to make it all
Capital market loans to corporations are either equity
loans or debt loans. An equity loan is made when a
corporation sells stock to investors. The money the
corporation receives in return for its stock can be used to
Growth of the global capital market
Deregulation and improvements in technology have
facilitated the growth of the international capital market.
Due to advances in communications and data
processing capabilities, the international capital markets
are always active around the globe.
International trading is an information intensive activity
that would not have been possible only a few decades
ago when computing and telecommunication capabilities
were much less developed.
The deregulation of capital flows, removal of limitations
on the types of services that can be provided by foreign
financial services firms, and a reduction in the restrictions
imposed on domestic financial services firms have all
contributed to the growth of the international capital
Global capital market risks
While capital is generally free to move internationally,
evidence to date suggests that most investors choose to
make long term investments in their home country and
only make short term opportunistic investments
A lack of information about the fundamental quality of
foreign investments may encourage speculative flows in
the global capital market.
The Eurocurrency Market
A eurocurrency is any currency banked outside of its
country of origin. Eurodollars, which account for about
two-thirds of all eurocurrencies, are dollars banked
outside the United States. Other important
eurocurrencies include the euro-yen and the euro-pound.
The term eurocurrency is actually a misnomer because a
eurocurrency can be created anywhere in the world; the
persistent euro- prefix reflects the European origin of the
market. The eurocurrency market has been an important
and relatively low-cost source of funds for international
The Eurocurrency got its origin as holders of dollars
outside the US, initially communist countries but later
also middle eastern countries, wanted to deposit their
dollars but were afraid that they may be confiscated if
deposited in the US.
The lack of government regulation makes the
Eurocurrency market attractive to both depositors and
borrowers. Due to the lack of regulation, the spread
between the Eurocurrency deposit rate and the
Eurocurrency lending rate is less than the spread
between the domestic deposit rate and the domestic
lending rate.
This gives Euro banks a competitive
The lack of regulation is also a drawback of Eurocurrency
deposits, as the risk of forfeiture is greater than for
domestic deposits. There is also a risk of currency
fluctuations that would not arise if funds were held
domestically in the domestic currency.
The Global Monetary System
After learning about the International Equity Market, this
module tackles the International Bond Market. The global
bond market grew rapidly during the past two decades.
Bonds are an important means of financing for many
companies. The most common kind of bond is a fixedrate bond. The investor who purchases a fixed-rate bond
receives a fixed set of cash payoffs. Each year until the
bond matures, the investor gets an interest payment and
then at maturity she gets back the face value of the
Bonds are the most common form of debt instrument,
which is basically a loan from the holder to the issuer of
the bond. The international bond market consists of all
the bonds sold by an issuing company, government, or
entity outside their home country. Companies that do not
want to issue more equity shares and dilute the
ownership interests of existing shareholders prefer using
bonds or debt to raise capital (i.e., money). Companies
might access the international bond markets for a variety
of reasons, including funding a new production facility or
expanding its operations in one or more countries. There
are several types of international bonds, which are
detailed in this module.
The Global bond market
The international bond market is divided into three
Domestic bonds:
Issued locally by a domestic borrower.
Usually denominated in the local currency.
Foreign bonds:
Issued on a local market by a foreign borrower
Usually denominated in the local currency.
Placed mainly in countries other than the one in whose
currency the bond is denominated.
Distinction between bond markets.
Domestic bonds.
- BDO issues a bond denominated in Peso in
- Issue is underwritten by a syndicate of Philippine
securities houses.
Foreign bonds.
- BDO issues bonds denominated in USD in the U.S.
- Issue is underwritten by a syndicate of U.S. securities
- BDO issues bonds to be placed internationally.
- Issue is underwritten by an international syndicate of
securities houses.
- Issue is denominated in any currency.
The Foreign bond and Eurobond markets make up
the international bond market.
Foreign bonds are sold outside of the borrower's country
and are denominated in the currency of the country in
which they are issued.
Technically, Foreign bond may be sold by a company,
government, or entity in another country and issued in
the currency of the country in which it is being sold.
There is foreign exchange, economic, and political risks
associated with foreign bonds, and many sophisticated
buyers and issuers of these bonds use complex hedging
strategies to reduce the risks. For example, the bonds
issued by global companies in Japan denominated in yen
are called samurai bonds. As you might expect, there are
other names for similar bond structures. Foreign bonds
sold in the United States and denominated in US dollars
are called Yankee bonds. In the United Kingdom, these
foreign bonds are called bulldog bonds. Foreign bonds
issued and traded throughout Asia except Japan, are
called dragon bonds, which are typically denominated in
US dollars. Foreign bonds are typically subject to the
same rules and guidelines as domestic bonds in the
country in which they are issued. There are also
regulatory and reporting requirements, which make them
a slightly more expensive bond than the Eurobond. The
requirements add small costs that can add up given the
size of the bond issues by many companies.
A Eurobond is a bond issued outside the country in
whose currency it is denominated. Eurobonds are not
regulated by the governments of the countries in which
they are sold, and as a result, Eurobonds are the most
popular form of international bond. A bond issued by a
Japanese company, denominated in US dollars, and sold
only in the United Kingdom and France is an example of
a Eurobond.
A Eurobond issue is normally underwritten by an
international syndicate of banks and placed in countries
other than the one in whose currency the bond is
The Eurobond market is an attractive way for companies
to raise funds due to the absence of regulatory
interference, less stringent disclosure requirements than
in most domestic bond markets, and the favorable tax
status of Eurobonds.
Euro denominated bonds have become increasingly
common. One advantage of these bonds is that the risks
associated with exchange rates are lower, since the Euro
is actually a basket of currencies.
Global Bond
A global bond is a bond that is sold simultaneously in
several global financial centers. It is denominated in one
currency, usually US dollars or Euros. By offering the
bond in several markets at the same time, the company
can reduce its issuing costs. This option is usually
reserved for higher rated, creditworthy, and typically very
large firms.
The Global equity market
There is no international equity market in the same sense
that there are international currency and bond markets.
Instead there are a number of separate equity markets
that are linked via specific equities and overall market
Who uses these markets?
Foreign investors are increasingly investing in different
national equity markets, primarily as a way of diversifying
risk by diversifying their portfolio of stock holdings
across nations.
Today, firms are listed on multiple national exchanges
and have their shares owned by large number of
shareholders from different nationalities. Companies are
beginning to list their stock in the equity markets of other
nations, primarily as a prelude to issuing stock in the
market to raise additional capital. Other reasons for
foreign listings include facilitating future stock swaps,
using the company's stock and stock options to
compensate local management and employees,
satisfying local ownership desires, providing access to
funding for future acquisitions in a country, and
increasing the company's visibility to local employees,
customers, suppliers, and bankers
Foreign exchange risk and the cost of capital
When borrowing funds from the international capital
market, companies must weigh the benefits of a lower
interest rate against the risks of an increase in the real
cost of capital due to adverse exchange rate
Using forward rates cannot typically remove the risk
altogether, particularly in the case of long-term
Managerial implications
Focusing on the external business environment, the
Implications for Business section shows how the
concepts apply to the practice of international business.
The implications of the material discussed in this module
are quite straightforward but no less important for being
obvious. The growth of the global capital market has
created opportunities for international businesses that
wish to borrow and/or invest money. By using the global
capital market, firms can often borrow funds at a lower
cost than is possible in a purely domestic capital market.
This conclusion holds no matter what form of borrowing
a firm use—equity, bonds, or cash loans. The lower cost
of capital on the global market reflects greater liquidity
and the general absence of government regulation.
Government regulation tends to raise the cost of capital
in most domestic capital markets. The global market,
being transnational, escapes regulation. Balanced
against this, however, is the foreign exchange risk
associated with borrowing in a foreign currency.
On the investment side, the growth of the global capital
market is providing opportunities for firms, institutions,
and individuals to diversify their investments to limit risk.
By holding a diverse portfolio of stocks and bonds in
different nations, an investor can reduce total risk to a
lower level than can be achieved in a purely domestic
setting. Once again, however, foreign exchange risk is a
complicating factor.
The trends noted in this chapter seem likely to continue,
with the global capital market continuing to increase in
both importance and degree of integration over the next
decade. Perhaps the most significant development will
be the emergence of a unified capital market within the
EU by the end of the decade as those countries continue
t o w a rd e c o n o m i c a n d m o n e t a r y u n i o n . S u c h
development could pave the way for even more rapid
internationalization of the capital market in the early
years of the next century. If this occurs, the implications
for business are likely to be positive.
What are the top 5 reasons why tariffs are being used?
Response: Protecting Domestic Employment
Response: Protecting Consumers
Response: Infant Industries
Response: National Security
Response: Retaliation
Item 1
Previously, the Forex market was traded primarily by
banks, large financial institutions, and governments.
Response: True
Correct answer: True
Score: 1 out of 1
Item 2
Which of the following factors is affected in determining
exchange rates when domestic inflation or deflation
affects the exchange rate by affecting the demand and
supply of domestic currency in the foreign exchange
Response: Changes in prices
Correct answer: Changes in prices
Score: 1 out of 1
Item 3
Which of the following refers to the the most common
type of forward transaction?
Response: Swap
Correct answer: Swap
Score: 1 out of 1
Item 4
On January 1981 (as part of changes beginning during
1978) the Bank of China allowed certain domestic
"enterprises" to participate in foreign exchange trading.
Response: True
Correct answer: True
Score: 1 out of 1
Item 5
The following are the factors affecting in determining
exchange rates except?
Response: None of the above
Correct answer: None of the above
Score: 1 out of 1
Item 6
In this transaction, money does not actually change
hands until some agreed upon future date.
Response: Forward
Correct answer: Forward
Score: 1 out of 1
Item 7
Forex first existed in ancient time. Money-changing
people, people helping others to change money and also
taking a commission or charging a fee were living in the
times of the Talmudic writings (Biblical times).
Response: True
Correct answer: True
Score: 1 out of 1
Item 8
A foreign exchange option (commonly shortened to just
FX option) is a derivative where the owner has the right
but not the obligation to exchange money denominated
in one currency into another currency at a pre-agreed
exchange rate on a specified date.
Response: True
Correct answer: True
Score: 1 out of 1
Item 9
The Foreign Exchange Market or FOREX Market is one in
which foreign currency or foreign exchange is bought
and sold, either Over the Counter (OTC) or through
currency exchanges.
Response: True
Correct answer: True
Score: 1 out of 1
Item 10
Which of the following refers to the measure of the
change in the prices of consumer goods across over 200
different categories?
Response: Consumer Price Index
Correct answer: Consumer Price Index
Score: 1 out of 1